With $929 billion in commercial real estate debt coming due, can America's community banks weather this crisis?
Entrepreneur Tom Ellsworth believes the US banking system is in the midst of a “crisis,” and there are two opposing issues that are battering its foundations.
Of the $4.7 trillion in outstanding commercial mortgages held by U.S. lenders and investors, one-fifth, or $929 billion, will come due in 2024, according to the Mortgage Bankers Association's (MBA) 2023 Commercial Real Estate (CRE) Loan Maturity Volume Study.
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This means problems for America's smaller commercial banks and private mortgage lenders, who are feeling the strain of America's high interest rate environment.
“The Fed just said interest rates are going to be higher. This is bad news!” Ellsworth said on a recent episode of the PBD podcast. “We're going to see bank failures and commercial real estate going into receivership.”
Is he right that the US banking system and CRE sector are in danger?
Banks are under “stress”
As the high interest rate environment continues, there are concerns that some smaller financial institutions and regional banks may fall below minimum capital requirements set by the Federal Reserve.
Brian Graham, co-founder and partner at consulting firm Claros Group, told CNBC that smaller lenders and banks with less than $10 billion in assets are “stressed” but not necessarily “close to insolvency.”
Claros Group recently reported that 282 of the top 4,000 U.S. banks face the dual threat of losses from maturing commercial real estate loans and rising interest rates, but Graham doesn't foresee a repeat of 2023, which saw the devastating failures of Silicon Valley Bank, Signature Bank and First Republic Bank.
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Instead, he believes “we will see fewer bank failures” because banks are prepared for such situations and have learned from the events of the last year, but he acknowledged that Americans could still “be hurt by the stress.”
Responding to this relatively optimistic analysis on the PBD podcast, Ellsworth said: “What do you mean by 'fewer bank failures'? That's like saying, 'Hey, after the hurricane passes, there will be less rain,' but it's still raining!”
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The looming storm
So why do maturing CRE loans and the Federal Reserve’s “higher for longer” interest rate regime create such bad conditions for America’s private lenders and community banks?
According to the International Monetary Fund (IMF), prolonged high interest rates have exposed vulnerabilities in banks around the world.
A blog post by the IMF explained: “Loan losses are likely to rise as both consumers and businesses face higher borrowing costs, particularly due to job losses and falling business revenues. Alongside loans, banks also invest in bonds and other debt securities, which fall in value when interest rates rise. Banks may be forced to sell these at a loss if they face sudden deposit withdrawals or other funding pressures.”
Theoretically, if these smaller lenders and regional banks suffer liquidity problems as a result of rising interest rates, the amount of debt available to new CRE borrowers could evaporate, leading to massive defaults.
The scale of the problem could be substantial, with $929 billion in CRE mortgages maturing (and being sold) this year, according to the MBA. But the diversification needed to stabilize the sector is there, as the CRE sector's reliance on local bank lending has been “grossly overstated or misrepresented,” according to Moody's Analytics.
It's also important to consider that banks must pass Federal Reserve stress tests, which evaluate whether they have enough capital to absorb losses in stressful situations, such as the intersection of high interest rates and CRE debt maturities.
Government oversight reduces some of the likelihood of bank failures, but banks still need to be prepared to withstand pressure.
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This article is for informational purposes only, should not be construed as advice, and is provided without warranty of any kind.